Debt Ceiling Negotiations to End Badly

July 3, 2011

By this time next month, the long-running battle over raising our nation’s debt ceiling will have come to a resolution, one way or another.  Either the U.S. will be forced to default (or not?  see below) or an agreement will have been reached to raise the ceiling in return for a cut in the projected size of the deficit.  Possible outcomes range from a catastrophic global financial melt-down at one end of the scale to a mere collapse into the 2nd dip of the recession at the other end of the scale.  There are no possible good outcomes here.  This is going to end badly. 

Those who have bought into the notion that cutting our deficit, especially by cutting government spending, will somehow stimulate the economy couldn’t be more wrong.  Cutting the deficit, regardless of whether it’s done by cutting spending, increasing revenue or some combination of the two, will take money out of the economy.  Collecting revenue takes money out of the economy as Republicans correctly point out.  Government spending puts money back in, as Democrats correctly claim.  Taking more out in the form of revenues or putting less back by cutting spending leaves the economy with less than it started.  While that helps the nation’s balance sheet in the long run, leaving the next generations better off, it’s bad for the economy in the short run. 

So the only possible outcomes here are either a U.S. default on its interest obligations on its bonds, which could conceivably render all U.S. bonds instantly worthless, wiping out banks and investors across the globe, or a recession-triggering pulling of the rug from under the feet of the U.S. economy, an economy barely kept above water by trillions in deficit spending by the federal government and quantitative easing by the Federal Reserve – all of which has come to an end.  No wonder the two sides are battling so bitterly.  Both know the outcome will be bad.  Each wants the other to take the blame. 

And that’s not the half of it.  Even if a deal is reached, the deficit is cut and the debt ceiling is raised, the only thing that will have been accomplished is that the “can” will have been kicked a bit further down the road.  It’s not as though we’ll be cutting the deficit; we’ll only be cutting the projected growth in the deficit.  The deficit, projected to grow by another $15 trillion or so in the next ten years, will instead grow by only $10 or 11 trillion, a situation that will leave us in far worse shape than now.  What are the odds that it’ll be dealt with then?

I’m not arguing that the problem shouldn’t be addressed or that no good outcome is possible regardless of what our lawmakers do.  The problem is that nowhere in these talks is the real problem that drives the deficit spending being addressed, and that is the trade deficit.  As I said earlier, anything that takes money out of the economy, which includes taxes, cuts in deficit spending – even personal savings, is a drag on the economy.  And our trade deficit currently drains over $500 billion per year from the economy.  If that draw-down from the economy isn’t made up by deficit spending, then economic recession is absolutely unavoidable.  Furthermore, without any deficit spending, then the U.S. will not be issuing any more bonds, leaving foreign countries with trade surpluses with the U.S. no way to plow those dollars back into the American economy, throwing a big monkey wrench into the gears of the global economy.  Ultimately, that might be a good thing, forcing a rebalancing of the global economy and global trade. 

So, without a comprehensive approach to fixing our economy that includes restoring a balance of trade (and perhaps even addressing our goofy immigration policy, but that’s a different topic), merely cutting the deficit and raising the debt ceiling is just another round in a game of economic whack-a-mole, a futile effort to deal with economic side-effects that pop up faster than Congress can swing its little economic mallet. 

Greece is a good example of what we’re facing.  Like the U.S., Greece has a large trade deficit – about the same as the U.S. in per capita terms.  Like the U.S., Greece is heavily dependent on imported oil.  And like the U.S., its debt exceeds its GDP and has been growing rapidly.  The austerity measures imposed upon Greece by its creditors have resulted in violent civil unrest in that nation in recent weeks.  And the Euro zone has warned Greece that it faces loss of its sovereignty and the prospect of much higher unemployment as these austerity measures take hold.  (See http://www.reuters.com/article/2011/07/03/us-eurogroup-greece-idUSTRE76219J20110703.)  The U.S. will face the exact same things if we implement drastic deficit reduction programs without addressing our trade deficit.

Things are coming to a head soon and, regardless of how it turns out, it won’t be good. 

* * * * *

Regarding the whole issue of default, there is a little-known sentence in the 14th amendment that seems to forbid the U.S. from failing to pay its obligations.  That sentence reads, “The validity of the public debt of the United States … shall not be questioned.”  The Obama administration is considering whether, in the event that the debt ceiling isn’t raised, it can invoke this statement and ignore the debt ceiling and continue paying the government’s bills.  Imagine the ramifications.  Without the limitation of the debt ceiling, there will be no rein on government spending.  It would be interesting to see just how fast an amendment to balance the budget, already being suggested by Republicans, would be introduced.  But, again, bear in mind that balancing the budget without balancing trade is a virtual (if not physical) impossibility.  At least such an amendment would pretty quickly force a re-evaluation of trade policy. 


Is Globalization in Its Final Days?

February 19, 2011

http://news.yahoo.com/s/ap/20110219/ap_on_re_us/g20_finance_ministers

Globalization, a process begun in wake of World War II with the signing of the Global Agreement on Tariffs and Trade in 1947, may now be in its last days.  Whether those days number in the thousands or hundreds is yet to be seen but, make no mistake, the end of global economic cooperation is near.  As reported in the above-linked article about the G2o meeting in Paris, export-dependent nations, lead by China, are dragging their feet on the 2-step effort to measure and rectify global economic imbalances. 

Finance chiefs of the world’s dominant economies on Saturday pressured China to drop its resistance to a deal on tracking dangerous imbalances in the global economy, in an effort to revive the Group of 20 rich and developing nations as the forum to prevent further financial crises.

More than any other imbalance, current accounts (trade supluses and deficits), have taken center stage in the talks.

China has so far opposed targeting current account surpluses — which show that a country sends much more goods and capital abroad than it receives …

But patience is wearing thin.  Global leaders understand that such imbalances were at the root of the economic collapse of the past couple of years and that the capacity to deal with another such crisis has been exhausted.

The stakes are high: French Finance Minister Christine Lagarde warned Friday that a failure to address imbalances “leads us straight into the wall of another debt crisis,” while President Nicolas Sarkozy said that countries must not get complacent as some parts of the world are starting to recover from the crisis while others are still lagging behind.

“That would be the death of the G-20,” Sarkozy warned.

The following is perhaps the most frank admission I’ve seen yet of the role that global trade imbalances played in the global economic melt-down:

What is clear to most economists is that sticking to the status quo could be fatal.

In the years before the financial meltdown of 2008, countries with trade surpluses plowed money into mortgage and other investments in the United States, helping escalate their value, U.S. Federal Reserve Chairman Ben Bernanke told his G-20 colleagues Friday. But the U.S. failed to safely absorb money flooding in from emerging nations like China, Middle Eastern oil countries and industrialized countries in Europe, Bernanke said.

“… the death of the G20.”  “Sticking to the status quo could be fatal.”   Strong words that highlight the urgency.  Bernanke and others know very well that a repeat of the recent economic crisis will be exactly that – fatal.  The global economic system will come completely unglued and it will be every man (country) for himself. 

How much time is left?  That’s the big, unanswered question.  But if recent history is any indication, it’s not long.  Consider this:  the economic bubbles we’ve witnessed in the last two decades have been fueled by the trade imbalances.  American trade deficit dollars have to come back to America, one way or another.  In the ’90s, those dollars bought stocks and inflated a huge stock market bubble.  It took about six years for that to run its course and for the bubble to burst in March of 2000.  Then those trade deficit dollars were funneled into real estate in the form  of mortgage-backed securities.  Once again, it took about six years before that nearly collapsed the entire global financial system. 

It’s now been about three years since that collapse in late 2007/early 2008, and nothing has been done to address trade imbalances.  First, trade dollars inflated a bubble in treasuries – a bubble whose bursting has been delayed by the Fed’s program to buy up new treasury issues.  More recently, those trade dollars are re-inflating another stock market bubble.  History suggests that there may only be another three years to go before the next economic collapse.  If the G20 can’t address these imbalances in a coordinated way, then the U.S. will have to go it alone and do what’s necessary to restore a balance of trade.  It’s that or economic oblivion.

Export-dependent nations, most notably China, will never go along with any G20 plan to rectify imbalances, wiping out their huge trade surplus.  They may play along a bit longer to buy time, but it won’t buy them much.  When time runs out, so too will the global economic engineering that has forestalled the day of reckoning for overpopulated, export-dependent nations.  From my perspective, that day can’t come soon enough.


Tension Over Trade Imbalances Heating Up

November 5, 2010

http://www.cnbc.com/id/40021005

As reported in the above-linked CNBC article, tensions over trade imbalances are heating up, not just in China, as head-lined in the article, but in Japan and Germany as well.  It seems that the U.S. has proposed that other nations “cap” their current account surpluses (trade surpluses) at 4% of GDP:

The United States proposed at the G20 finance ministers’ meeting last month that countries should cap current account surpluses or deficits at 4 percent of GDP as part of efforts to rebalance the global economy.

It was one thing for Obama to suggest at the height of the global economic crisis that nations voluntarily work together toward rebalancing the global economy.  All agreed, knowing full well that there would be no follow-through by the U.S. and they could return to business as usual.  But it’s an entirely different matter for the U.S. to begin insisting on quotas. 

China on Friday pushed back strongly against U.S. policies ahead of the G20 summit, ridiculing Washington’s plan to impose current account targets and warning of risks in the Fed’s monetary easing.

… The idea of numeric targeting met strong resistance from Japan and Germany …

U.S. patience with huge trade imbalances is wearing thin.  Now, even the Fed has joined the fight with its new round of quantitative easing.  If voluntary approaches and pressure on currency valuations don’t work, then the unavoidable question for the U.S. is “what do we do next?”  There are only a couple of options – the ones I’ve steadfastly maintained are the only viable options:  U.S.-imposed quotas and tariffs. 

Forget all the post-election banter about “Obamacare” and about government spending.  It’s all dwarfed in significance by this escalating global war for employment.  The global trade regime set up in the wake of World War II in the hopes of preventing the next war has back-fired and is crumbling, and may very well have provided the catalyst for the next one.


Shocking 2nd Quarter GDP Report Points to Further Recession

August 5, 2010

I posted a few days ago when the 2nd quarter GDP report was released, and promised to follow up when I could get back to my desk and crunch the numbers to arrive at per capita GDP, with and without stimulus spending. 

I was so shocked at the results that I had to double and triple-check the figures!  Remember that the government reported that real GDP (adjusted for inflation) rose at an annual rate of 2.4% in the 2nd quarter, a pretty anemic report.  When expressed in per capita terms, accounting for population growth, real per capita GDP rose at an annual rate of only 1.5%.  But the really shocking news is just how much the stimulus plan spending contributed to that anemic report.  In the 2nd quarter, Economic Recovery Act spending soared to $182 billion, raising the total amount of stimulus money spent so far by 58% in one month! 

It’s important to track what the underlying economy is doing with this stimulus spending stripped away, because the stimulus spending is going to end soon.  If this spending is stripped out of the GDP report, real per capita GDP fell in the 2nd quarter by 3.6%, the worst rate of decline since the economic crisis began in 2008!  Here’s the chart:

Real Per Capita GDP

I can’t account for the explosion of stimulus spending in the 2nd quarter.  It may be due to the homebuyer tax credits that expired at the end of June.  There’s also the possibility that there was simply some “catch up” in reporting in the 2nd quarter.  Regardless, this is an absolutely devastating GDP report and portends extremely serious problems for the economy when the stimulus plan has run its course. 

You may recall that I’ve been predicting another massive stimulus plan to follow on the heels of this one.  But there’s simply no appetite in Congress for passing another.  Well, I read rumors this morning that the Obama administration plans to bypass Congress in August and effectively implement another $800 billion in stimulus by ordering Fannie Mae and Freddie Mac to forgive part of the balance on mortgages that are “under water.”  He can do this without Congress’ approval.   (Here’s a link:  http://blogs.reuters.com/james-pethokoukis/2010/08/05/an-august-surprise-from-obama/)

None of this comes as a surprise.  The stimulus bill bought Obama time to make real fixes to the economy – primarily fixes to our trade policy that would correct trade imbalances and bring home millions of high-paying manufacturing jobs.  But no fixes were made.  Now the stimulus money is spent and there’s nothing to show for it. 

As if the 2nd quarter GDP report wasn’t bad enough, analysts are already expecting a significant downgrade when the next revision comes out next month, lowering their forecasts to 1.7%.  All indications are that the economy is in serious trouble.  Like I said in my last post, look for the economic you-know-what to start hitting the fan in coming months.


Clinton to the Rescue? Yikes.

July 15, 2010

http://www.reuters.com/article/idUSTRE66D1DX20100715?type=politicsNews

President Obama, apparently having emptied his bag of economic tricks with the stimulus package and now bereft of ideas for what to try next, is soliciting advice from former President Bill Clinton who, according to the above-linked article:

… presided over the 1990s economic boom …

and was the last president to turn a budget surplus since Richard Nixon had a miniscule surplus ($3 billion) in 1969.  Never mind the fact that a chimp could have done the same thing in the late ’90s, in light of the stock market bubble, the dot com bubble and the explosion in PC, internet and cell phone technology and manufacturing (all of which has since been out-sourced to China and others).  Clinton was too busy enjoying a fine cigar with his intern to have even known what was going on. 

So what’s Clinton likely to advise Obama to do? Provide more stimulus money for alternative energy?  Give more tax breaks to industry?  Implement more free trade deals?  Yeah, granting China MFN (most-favored-nation) status worked out real well, didn’t it, Bill? 

What’s worrisome here is that this is a thinly-veiled admission by the Obama administration that their economic strategy, having run its course, leaves the economy heading back into a slump, and they’ve got nothing left.  The stimulus halted the slide temporarily, but stimulated nothing.  Now we’re back in the same boat. 

No, actually, it’s worse.  At least before the financial melt-down, we had a housing bubble and easy credit to make us think things were OK.  Now we don’t even have that.  Nothing’s been done about our broken trade policy.  No manufacturing jobs have come back home and global trade imbalances are returning to their pre-crisis levels.  And deficit spending is about as popular as a turd in a punch bowl.

I’m sure we’ll soon see a shake-up in Obama’s economic team.  Summers and Romer will probably be replaced by a couple of other ivy-league economists serving up the same platitudes about economic growth and free trade.  Not that it will make any difference.

I suppose we should be thankful for one thing:  if Clinton weren’t here, Obama would have to turn to Jimmy Carter for advice.


Global Economy’s Achilles Heel: Unemployment

June 2, 2010

http://www.reuters.com/article/idUSTRE6504EU20100601

During the past couple of months, the world has been coming to grips with something that no world political or financial leaders want to admit – the global economy no longer works.  It’s collapsing under the weight of the one factor that economists never accounted for – unemployment. 

As reported in the above-linked article, the International Labor Organization (ILO), an agency of the U.N., is warning that measures being taken by governments around the world to reduce debt will likely lead to a recession, with rising unemployment potentially threatening social stability.  Yesterday, in an about-face from its recent lecturing of the U.S. to get its fiscal house in order, China also cautioned against moves to rein in debt.  (The Chinese are smart enought to know that every dollar or euro cut from government spending in the U.S. and Europe translates into lost exports for them.) 

But financial markets have become absolutely intolerant of high debt levels.  Ratings agencies like Moody’s and S&P, breathing a sigh of relief that they weren’t hammered harder with law suits and criminal prosecution for their role in the global financial collapse that began in 2008, are now ruthless in their slashing of credit ratings for anyone with the slightest potential of default. 

Without deficit spending, the global economy with its requisite trade imbalances doesn’t work.  Without trade imbalances, badly overpopulated nations like Germany, Japan and China face staggering unemployment.  With the trade imbalances, big importers like the U.S. face eventual default. 

The problem is that, with much of the world so densely populated that per capita consumption has been driven into decline, deficit spending is the only thing left in economists’ bag of tricks to prop up consumption and hold rising unemployment at bay.  Globalization is an unemployment sharing mechanism that spread unemployment away from overpopulated economies to the U.S., where gimmicks like the dot-com boom of the ’90s and the housing bubble of the ’00s could keep unemployment swept under a rug for a while.  But that ploy’s run its course.  Now, not all the king’s treasury secretaries or all the kings central bankers can put this Humpty Dumpty together again. 

It’ll probably take years for all of this to play out, but what we’ll see is an intensifying global battle for employment, World War III fought on an economic stage.  It’ll get worse as the world population soars by several billion more.  Whether the war can remain confined to the economic stage without spreading to the battlefield – only time will tell.


Economy Sheds 589,000 Jobs; Unemployment Hits 12.0%

January 8, 2010

http://www.reuters.com/article/idUSN0720304820100108

As reported in the above-linked Reuters article, the Bureau of Labor Statistics (BLS) reported this morning that the economy lost 85,000 jobs in December and unemployment held steady at 10.0%.  But a closer look at the data reveals a much worse picture. 

The “jobs lost” data is based on the BLS’s “non-farm payrolls” report, which shows non-farm payrolls declining by 85,000 in December to 130,910,000.  But the unemployment figure is based upon a broader measurement of employment level that includes the agriculture sector.  By that measure, total employment fell by 589,000 in December to 137,792,000.  So why didn’t unemployment rise?  Because the other component of that calculation – the “civilian labor force” – contracted once again by 661,000 in spite of the fact that the population grew in December by 200,000.  The government has been using this phenomenon of a magically vanishing labor force to hold down the unemployment rate since the onset of the recession in late 2008. 

If we assume the labor force is a constant percentage of the population, then the real unemployment rate rose by 0.4% in December to 12.0%, the highest level since the Great Depression.   And the broader measure of unemployment, which includes those who have given up looking for work and those working part-time when they really need full-time work, rose to 21.3%. 

The following is my calculation of unemployment, using the government’s own data:

Unemployment Calculation PDF

(By the way, if you compare this spread sheet to the one included in my post on the same subject last month, you’ll see that some of the data has changed slightly.  That’s because the BLS revised the data for small changes in population estimates.)

The following is a chart of the same data, just to make it easier to visualize what’s happening:

Unemployment Chart

Notice that the government’s methods for calculating unemployment (both U3 and U6) correlated very closely with my own method until the start of the recession, when the labor force began disappearing. 

Finally, some observations about the December data:

  • The employment level is virtually unchanged from the level in December of 2000. 
  • During that same time frame, the population has grown by 25 million. 
  • In the last 12 months, the employment level has fallen in ten of those months and has risen twice (most recently in November), for a total loss of 5.2 million jobs.  Of those ten months in which losses occurred, the loss in December was the 3rd worst.
  • In the last 24 months, the employment level has fallen in 19 of those months, for a total loss of 8.2 million jobs. 
  • As you can see from my chart of U3a unemployment, contrary to economists who are hailing the slowing rate of job losses, unemployment continues to rise unabated. 

Since the Obama administration continues to sit on its hands when it comes to restoring a balance of trade, none of this is a surprise.  It’s likely to get worse.  Stay tuned.


’00-’09: A “Lost Decade” or Something Worse?

January 4, 2010

As 2009 and the first decade of the twenty-first century drew to a close, many analysts proclaimed it the “lost decade.”  The stock market fell.  So too did home values.  We ended the decade with unemployment levels not seen for decades.

But to call the ’00-’09 decade a “lost decade” implies that it may just be an anomaly, and that better decades are sure to follow.  It’s possible that something darker has happened.  Quite possibly, this was the decade in which the U.S. (and perhaps the world) reached the economic tipping point I predicted in Five Short Blasts, beyond which further economic decline is inevitable as long as we cling to the economic theories that  have held sway for centuries. 

Think back to Figure 6-1 in the book, the graphic depiction of my “Theory of Population Density-Induced Decline in Per Capita Consumption.”  Since you may not have the book handy, here it is again:

Figure 6-1

To summarize, this illustration predicts that, beyond some optimum population density, while the population (and thus the work force) continue to grow, total consumption of products will also continue to grow, but at a slower rate, due to declining per capita consumption.  As per capita consumption declines, so too does the standard of living and quality of life as unemployment and poverty begin to climb. 

The ’00-’09 decade provides ample evidence that this process has begun.  First of all, while the U.S. population continued to grow throughout the decade at an average rate of about 1%, the main gauge of the U.S. macro-economy – gross domestic product, or GDP – grew at an average annual rate of 1.9%.  It fell only once during the decade, in 2009 (although the data for the final quarter of 2009 has not yet been released).  Growth in GDP is expected to resume in 2010.

Population & GDP

In spite of that steady growth in the population and almost-as-steady growth in GDP, individual Americans didn’t fare so well.  Although the population grew by 13.1% during the decade, employment grew by only 3.0% and only grew 0.6% over the last nine years of the decade.  It actually fell by 5.3% during the last two years.  Employment is now at its lowest level in six years – the longest stretch in U.S. history without growth in employment.

employment

It should then come as no surprise that median household income actually fell for the entire decade.  (The data for 2009 has not yet been released, but is expected to show further decline.)  Median household income is now at its lowest level since 1997.

median household income

Another measure of the financial well-being of individual Americans is their net worth.  Unfortunately, the Federal Reserve only measures this every three years, and the last survey was taken in 2007, before the massive loss of stock market and real estate values.  When measured again in 2010, it will almost surely show a decline for the decade. 

Finally, it should be noted that China was granted “most favored nation” status by the U.S. at the very beginning of the decade, opening the door to free trade with China.  This was significant because free trade wipes out borders in economic terms, driving our “effective” population density higher or lower depending on the population density of the trading partner in question.  Free trade with China sent our “effective” population density soaring, quickly pushing us to the right on the x-axis of Figure 6-1 above. 

Did it push us so far to the right that we breached the “optimum” population density?  If it did, my theory predicts that, in spite of continued growth in the macro-economy, the fate of individual Americans would go into decline.  That’s exactly what happened for the first time in the ’00-’09 decade.  Employment was stagnant.  Unemployment soared.  Household income and net worth both fell. 

The question is whether the past decade was an economic anomaly or the beginning of a trend.  I realize that I may be over-reaching here – that the deep recession of the past couple of years is just another economic blip – that the consequences of a growing population density may lie much further down the road.  But I don’t think so.  The stabilization of the economy that appears to have taken hold in the last few months of the decade is due solely to massive infusions of government money, an infusion that can’t be sustained indefinitely.  All indications are that if that government intervention is withdrawn now, the economy will resume its decline. 

It’s very possible that the past decade is the beginning of the trend that I’ve predicted and that, unless significant changes are made in trade and immigration policy, it’s likely that the coming decade has more economic pain in store for all of us.


3rd Quarter GDP Revised Down, Underlying Economy Still in Decline

December 22, 2009

This morning the Bureau of Economic Analysis issued its 3rd estimate of 3rd quarter GDP, revising it downward once again.  Its “advance estimate,” published in October, was that real GDP grew at an annual rate of 3.5%.  Last month, that was revised down to 2.8%.  This morning it was cut again, to 2.2%.

However, if we remove stimulus spending from the equation to see what’s really happening in the underlying economy, we find that chained GDP (expressed in constant 2005 dollars) fell in the 3rd quarter at an annual rate of 1.4%.  Stimulus spending added $113.2 billion to the economy in the 3rd quarter – an annualized rate of stimulus spending of $453 billion.  It’s important to understand what’s happening in the underlying economy because the stimulus spending will end soon, probably in early 2011. 

But GDP is the whole pie.  What’s really important is the slice of pie that each American gets.  When population growth is factored into the equation (and again, with stimulus spending factored out), we find that the underlying chained GDP per capita actually continued to decline in the 3rd quarter at an annual rate of 5.5%, falling from $41,270 per person to $40,704.  That’s better than the 9.0% rate of decline in the 2nd quarter, but a decline nonetheless.  And it’s the lowest level in 5-1/2 years.  Clearly, if the stimulus spending were stopped at this point, the economy would immediately slip back into recession. 

It’ll be interesting to see what happens in the 4th quarter next month.  3rd quarter GDP was goosed by the cash-for-clunkers program and by a lot of restocking following many months of inventory depletion by businesses.  That restocking rate is likely to slow, and auto sales fell back into a funk once the cash-for-clunkers program ended. 

The point is that the stimulus spending is helping a little, but it’s doing a poor job of boosting the underlying economy in any meaningful way.  We’re still waiting for Obama to begin addressing our trade imbalance as he had promised.  Until that happens, we can expect to keep muddling along with high unemployment.


Trade Policy Stupidity on Parade

December 12, 2009

http://www.reuters.com/article/idUSTRE5BA3TN20091211

Friday we were treated to a rare display of trade policy stupidity from both sides of the aisle in Congress, with each party opting for different but equally flawed approaches.  As reported in the first Reuters article (link provided above), Senator Reid has sent a letter to Chinese president Hu Jintao, begging him to un-peg the yuan from the dollar in the hope that such a move will correct the trade imbalance between the U.S. and China. 

“I know China is committed to moving to a free floating currency eventually. But China’s currency policy has been causing major distortions in the world economy for too many years already, and is continuing to do so now,” Reid, a Democrat, said in a December 9 letter released on Friday.

“In the mean time, I hope you would consider a significant revaluation to bring the value of the RMB in line with economic fundamentals, and after that, to return to a more robust version of the ‘managed float’ that your government previously maintained,” Reid said.

But, as is always the case in U.S. trade negotiations, we’re all bark and no bite:

Reid stopped short of threatening U.S. legislative action, but warned that “the one-way nature of the imbalances in our economic relationship is a major factor causing Americans to question the efficacy of our trade policy.”

This focus on currency valuation as the root cause of our trade deficit with China is just dumb.  First of all, if currency valuations are the problem, why are we not also demanding that Japan revalue the yen?  After all, in per capita terms (that is, relative to the size of the country), our trade deficit with Japan is four times as large as the deficit with China.  Why are we not criticizing the EU (European Union)?  Our per capita deficit with the EU is almost exactly the same as our deficit with China!  If we’re going to blame our problems on currency valuations, shouldn’t we at least be consistent?

But, secondly, currency valuations aren’t the problem.  The evidence doesn’t support a relationship between currency valuations and trade imbalances.  Two years ago, China did revalue the yuan by 20% vs. the dollar and, instead of falling, our trade deficit with China actually widened.  Since the 1970s, the dollar has fallen by over 300% vs. the Japanese yen.  Yet, instead of falling, our trade deficit with Japan exploded.  More recently, in the past year, the dollar has fallen dramatically vs. both the yen and the euro.  But there’s been no change in price for products imported from these regions.  If anything, Japanese automakers have actually been cutting prices. 

While it seems logical that trade imbalances should ultimately be resolved by currency revaluation, it doesn’t happen because badly overpopulated nations, utterly dependent on exports to sustain their excess labor capacity, overcome the effects of a strengthening currency by cutting costs, by subsidizing their manufacturers … doing anything and everything to maintain their trade surplus. 

Not to be outdone, on the same day, along come the Republicans, oblivious to what the blind application of free trade has done to us, pushing a trio of free trade deals, two of them benign while one is sure to be another disaster. 

http://www.reuters.com/article/idUSN1125942920091211

Republican U.S. congressional leaders urged President Barack Obama to work with them to win approval of long-stalled free trade pacts with Colombia, Panama and South Korea as early as possible in 2010.”We agree with you that these trade agreements provide important new commercial opportunities that will benefit our economy and create jobs without adding to our nation’s staggering budget deficit,” House of Representatives Republican leader John Boehner and three other top Republicans said in a letter to Obama sent late on Thursday.

“We ask that you jump-start the implementation process through your leadership, particularly by promoting all three of these pending trade agreements when you speak to the nation in your State of the Union address,” they said, referring to an annual speech to Congress usually in late January.

Colombia and Panama?  No problem.  We have a nice per capita trade surplus in manufactured goods with both countries.  Why?  Not because of a favorable currency valuation, but because the population density of both countries is about the same as our own. 

South Korea is an entirely different matter.  With a population density fifteen times that of the U.S., it’s no wonder that we have a per capita trade deficit in manufactured goods with South Korea that’s almost double that of China.  Why in the world would we want to repeat the same mistake with South Korea that we’ve made with so many other badly overpopulated nations?  Will we start complaining about South Korea’s currency valuation as soon as such a deal is signed?

Such inconsistent trade policy that’s rooted in theories not supported by the facts is just stupid, and the application of such stupid trade policy for the past several decades has driven us to the brink of economic collapse.  We may yet arrive at the point where Congress begins imposing tariffs to restore a balance of trade but, without an understanding of the role of population density and the accompanying rationale for the use of tariffs, it will be perceived as random, arbitrary and vengeful, and will likely make a complete mess of global trade.  But, then again, from the perspective of the U.S. economy, it couldn’t really be any worse.